Business Start-Up

VAT is a tax on consumer expenditure and is ultimately paid by the final customer. Most business transactions involve the supply of goods or services and VAT is payable if they are made:

a) in the United Kingdom;

b) by a taxable person;

c) in the course or furtherance of business and are not specifically exempted

or zero-rated.

VAT is collected by H M Customs & Excise and is normally payable quarterly.

There are two different types of registration - compulsory and voluntary:

A. Compulsory

A person who makes taxable supplies becomes liable to be registered if:

a) At the end of any month, the value of his taxable supplies in the period of one year then ending has exceeded the registration limit, which is £56,000 from 10 April 2003.

b) At any time, there are reasonable grounds for believing that the value of his taxable supplies in the next 30 days will exceed the £56,000 limit.

c) If, where a business carried on by a taxable person is transferred as a going concern, the taxable supplies for the twelve months prior to the transfer exceed £56,000.

In the most common situation, i.e. (a) above, the person must notify Customs & Excise of the liability within 30 days of the end of the month in which the value of the taxable supplies first exceeded £56,000. If, for example, the value of the taxable supplies first exceeded £56,000 in the twelve months to 31 March, then Customs & Excise must be notified by 30 April and VAT registration would commence on 1 May.

B. Voluntary

In certain circumstances, it is possible to register on a voluntary basis for VAT even though the value of taxable supplies may never exceed £56,000. This is normally only beneficial where the majority of supplies are being made to customers who are themselves VAT registered, e.g. it would not be beneficial for a domestic painter with taxable supplies of £30,000 to be registered, whereas it would be beneficial for a commercial or industrial painter with the same level of supplies.

The other situation in which a voluntary registration might be beneficial is where the supplies are all zero-rated and no VAT is charged on the transaction. All VAT suffered by the trader on expenses can be reclaimed from Customs & Excise.

In summary, the advantages and disadvantages of a voluntary registration are as follows:

Advantages

· enables input VAT suffered to be reclaimed;

· a VAT number can give the impression that a business is larger than it actually is

· which sometimes can increase the possibility of obtaining work.

Disadvantages

· the requirement to prepare VAT returns on a quarterly basis and to submit them within one month of the quarter end - is the amount of work involved worth it for the amount of input VAT that can be reclaimed?

Customs & Excise will visit the business about every five years to ensure that VAT is being properly accounted for.

a) Taxable Persons

It should always be remembered that it is a person that is registered for VAT and not a business. If a person has two separate different businesses, both with taxable supplies of £40,000, then that person will be required to be registered for VAT and account for VAT at the appropriate rate on the total supplies of £80,000.

It is possible to mitigate the effect of VAT by having one of the businesses operated by a limited company or by a partnership with a relative, but professional advice needs to be taken since Customs & Excise have the power to still treat the two businesses as one if strict criteria are not met.

b) Taxable Supplies

Taxable supplies are all supplies made by a business either to a third party or to the trader himself (goods for own use), which are not exempt supplies. Taxable supplies therefore include zero-rated supplies.

The major categories of exempt supplies are:

• Land (but not buildings)

• Insurance

• Postal services

• Betting, gaming and lotteries

• Finance

• Education

• Health and welfare

It is important that at the outset of a business, a trader establishes the VAT status of any supplies being made to avoid mistakes, e.g. the services of a physiotherapist are exempt, whilst the services of an acupuncturist are standard rated

There are three rates of VAT:

- two standard rates -

17.5%

5% - for certain supplies of fuel and power and sanitary goods

- zero-rated.

The four main areas of zero-rated goods are:

a) Food and agriculture (but excluding pet food and most catering);

b) Printed matter, including books and newspaper;

c) Young children’s clothing and footwear;

d) Passenger transport (but excluding hire cars, taxis and parking).

Any VAT charged by the business, whether at 17.5% or 5% is known as output VAT and the total charged or collected in the VAT quarter is payable to Customs & Excise.

Input VAT is the VAT that you are charged on your business purchases and expenses (the other persons output VAT) and is normally recoverable in full by a trader who only makes standard rated or zero-rated supplies. Businesses that make some exempt supplies (known as partially exempt businesses) have different recovery rules. The total input VAT suffered in the quarter is deducted from the output VAT charged or collected and the difference is either the amount of VAT due to Customs & Excise or the amount repayable by Customs & Excise.

The majority of input VAT is recoverable but there are special rules for:

cars;

petrol supplied for private usage;

business entertaining;

goods sold under a VAT second-hand scheme.

To reclaim VAT you have been charged as input VAT, you must hold valid evidence that you have received a taxable supply, which normally means a valid VAT invoice from a registered trader showing his VAT number and the amount of VAT charged.

VAT was originally described as a simple tax but has gradually become more and more complicated over the last twenty years with changes to the operation of VAT every year.

It is not always possible to calculate each quarter’s VAT liability by merely deducting input VAT incurred from 7/47 of the sales income and professional advice needs to be taken in the following situations:

• Importing and Exporting - either within or outside the European Union;

• Partial Exemption, i.e. where a business makes some exempt supplies, all the input VAT incurred is not necessarily recoverable;

• Retail Schemes, i.e. where both zero rated and standard rated supplies are made

which cannot be separately identified at the point of sale;

• Land and Property;

• Cash Accounting;

• Self-supplies;

• Second-hand schemes for motor cars, used boats, antiques, horses and ponies and others.

The impact of penalties has been considerably reduced since the early 1990’s and the possibility of any business suffering a serious misdeclaration penalty for an innocent error on their VAT returns is low.

The two most important penalties still in existence which every business should be aware of are:

a) Late registration penalty for not registering for VAT at the correct time. The penalty is based on a percentage of the VAT due between the date of registration and the date that the person was required to be registered and the percentage increases dependent upon the lateness of the registration. The penalty is in addition to the VAT that is due.

b) Default surcharge for traders that are persistently late in either submitting VAT returns and/or making payment of the liability due. The penalty is based on a percentage of the VAT due and is on a sliding scale.

Registration

(a) Should the business be registered?

(b) Is basis of registration correct?

(c) Are details on registration certificate correct?

(d) Do procedures exist for notifying Customs and Excise of relevant changes?

(e) Review position at regular intervals.

Preparation of returns

(a) Has return been received? If not, then obtain duplicate from VAT Office.

(b) Review sources of information.

(c) Prepare draft return.

(d) Check for accuracy and completeness.

(e) Make payment (if outputs exceed inputs)

Input Tax

(a) Do any restrictions on input tax exist?

- If “Yes”, does an agreed method exist?

- Does this method maximise input tax?

(b) Are invoice additions and calculations checked?

(c) Is input tax claimed at the earliest tax point?

(d) Are all claims properly supported?

- Ensure all supporting invoices kept.

Output Tax

(a) Are all income heads reflected for VAT accounting?

(b) Are all potential sources of notional supplies considered?

(c) Are all potential sources of income (asset sales, etc.) covered

by VAT accounting system?

(d) Is VAT captured at the correct tax point?

(e) Is VAT correctly applied where appropriate?